Ticker Reports for August 7th
What Are Bonds? A High-Level Overview
When you make a large purchase, like a house or an automobile, you often need to borrow money to balance your finances. Not everyone has a liquid $400,000 set aside for home ownership, but a more common scenario is a $80,000 down payment and a $320,000 loan from a bank. You get the house, the seller receives cash, and the bank receives an interest-earning asset.
Corporations and governments also sometimes need to borrow money for large capital expenditures, and they often do so by issuing bonds. Like a mortgage or car loan, bonds can be sold to investors and used in all kinds of portfolios. In this article, you’ll learn how bonds work, why investors seek them out, and what risks to be aware of when buying.
What Are Bonds?
A bond is a fixed-income investment representing a loan made by an investor to a borrower, usually a corporation or government. Like a loan, a bond typically has a fixed interest rate and a maturity date. The bondholder receives periodic interest payments, known as coupons, and the principal amount is repaid at the bond's maturity date. Bonds are used to raise funds for various projects and operations, offering investors relatively stable and predictable returns compared to stocks. Many institutions, including federal governments, municipal governments, mega-cap conglomerates and micro-cap startups issue bonds.
Imagine Fictional Company Z wants to raise money for a large project. The board could approve new stock issuance, which might be unpopular if it dilutes existing shareholders. They could also issue bonds, which don’t require relinquishing any equity but debt that must be repaid at a fixed future date. Company Z might choose the second option in this scenario and issue bonds to preserve shareholder equity.
Key Bond Terms
Before making an investment, you need to understand the fundamental terms associated with bonds.
Principal
Also referred to as Face Value or Par Value, the principal is the amount the issuer agrees to repay the bondholder at the end of the term. This differs from the bond's price, which can fluctuate based on several factors. If held to term, the bondholder will receive the total principal amount back regardless of the bond’s current market price.
Issuer
The entity that borrows the money by issuing the bond is called the issuer. This can be a government, municipality, or corporation.
Coupon Rate
Another way of saying interest rate, the coupon rate is fixed as an annual percentage of the bond’s principal. Coupons can be paid semiannually or annually, but the rate is always the principal divided by the annual interest received.
Maturity Date
Most bonds have a term after which the investor receives their principal back. This end date is known as the maturity date because the bond ‘matures’ and is retired by the issuer. Bonds can have short-term, medium-term, or long-term maturities.
A callable bond can be redeemed by the issuer before their maturity date at a specified call price, usually at a premium to the face value.
Yield
A bond’s yield is the amount investors can expect to earn from the asset based on market conditions. Yield differs from the fixed coupon rate because it fluctuates based on factors like interest rates and inflation. A bond’s yield has an inverse relationship to its price.
Credit Rating
Bonds aren’t a foolproof investment. If the issuer has financial difficulty, it may become unable to meet its obligations to bondholders. Because of this risk, credit agencies like Moody’s, Standard & Poor’s, and Fitch rate bonds based on the issuer's creditworthiness. Naturally, riskier bonds tend to come with higher yields.
Types of Bonds
All kinds of institutions can issue bonds, but the main types you’ll encounter as an investor include:
U.S. Treasuries
Treasuries are bonds issued by the U.S. federal government. They are named differently based on their duration: Treasury bills are 12 months or less, Treasury notes are one to nine years, and Treasury bonds are 10 to 30 years.
Municipal Bonds
Bonds issued by state, county, or city governments are known as municipal bonds, often called simply "munis." They are typically used to fund local projects like road construction or school funding and frequently offer tax breaks on investment gains.
Corporate Bonds
When a company issues debt to raise capital, it sells a corporate bond to investors. Corporate bonds are considered riskier than government bonds (primarily when issued by smaller companies) but often carry higher yields. Corporate bonds can be screened by company size, industry or sector, duration, and more.
Bonds issued by companies with lower credit ratings are known as high-yield or junk bond because they offer higher yields to compensate for the increased risk of default.
Convertible bonds are a type of corporate bond that can be converted into a predetermined number of shares of the issuing company's common stock. This conversion can typically be done at the bondholder's discretion and is usually defined by specific terms and conditions set at the time of issuance.
Agency Bonds
A mix between corporate and government bonds, an agency bond is issued by a government-sponsored enterprise like Fannie Mae or Freddie Mac. A common variety of agency bonds is mortgage-backed securities (MBS) which are securitized by individual mortgage payments.
Savings Bonds
Savings bonds are a type of bond issued by the federal government designed for individual investors to provide a safe and low-risk investment option. They offer tax advantages, such as deferral of federal taxes until redemption or maturity and exemption from state and local taxes. Savings bonds can typically be redeemed after a minimum holding period.
Zero-Coupon Bonds
Instead of coupon payments, zero-coupon bonds are issued at a significant discount to their face value and pay the full face value at maturity. The difference between the purchase price and the face value represents the interest earned by the bondholder. Zero-coupon bonds can be issued by various entities, including governments, municipalities, and corporations. These bonds tend to be more sensitive to changes in interest rates and are often used as long-term investments, providing a known return at a specific future date.
Why Invest in Bonds
If bonds usually have a lower expected return than stocks, why would investors favor them? The short answer is because not every investor seeks pure profit maximization.
Here are a few reasons to consider bonds:
- Stable Income: Bonds offer a level of predictability that assets like stocks or commodities cannot. If held to duration, a bondholder knows precisely how much interest they’ll earn and the principal they’ll receive when the bond matures. Even if you don’t hold until maturity, bonds provide consistent and stable income with minimal volatility.
- Lower Risk: Bonds tend to be less volatile than stocks. While they can fluctuate, bond prices often move more incrementally. Additionally, bondholder claims are ahead of stockholder claims in bankruptcy cases.
- Diversification: Bonds are often part of a diversified asset portfolio because they frequently move in the opposite direction of stocks. While inverse moves aren’t guaranteed, bonds and stocks diverge enough that investors use a combination of the two assets to assemble sturdy and diverse portfolios.
Risks Involved with Investing in Bonds
Low risk doesn’t mean that risk is entirely absent from a bond investment. Bond prices and yields fluctuate based on various factors, and holding them until maturity isn’t always an option. Here are five critical risks all bond investors should consider:
1. Interest Rate Risk
Bond prices can be volatile when interest rates move rapidly. For example, if interest rates rise, a previously issued bond may yield less than a newer one. In this scenario, the lower-yielding bond will be less attractive, and investors will demand a lower price compared to the newer bond with a higher rate. Long-duration bonds have more exposure to interest rate risk than short-duration ones.
2. Credit Risk
How solvent is the bond issuer? In the event of default, bondholders may lose money on their investment (if they receive anything at all). Companies with high default risk often have higher-yielding bonds since investors demand compensation for their exposure to a potentially troubled institution. Debt holders are higher up the chain than equity holders, but there’s no guarantee an insolvent company can repay its obligations.
3. Reinvestment Risk
Receiving steady annual coupon payments is a big benefit of bond ownership, but what if you can’t find other bonds with a similar rate and risk profile to reinvest in? This is known as reinvestment risk, which often occurs when interest rates are falling. For example, if you own a bond with a 6% coupon but can only find new bonds yielding 5%, you might be forced to take on more risk or accept a lower return. Double-risk whammy if your bond is callable; companies often recall their bonds with haste when interest rates drop
4. Inflation Risk
Bonds are considered fixed-income securities since coupon payments are usually permanent and the principal amount doesn’t change. However, fixed-income securities may struggle to keep up during periods of high inflation. Since inflation erodes purchasing power, bonds often fall out of favor for higher-yielding stocks during inflationary periods. Additionally, if you have a fixed income portfolio, your annual coupon payments could fail to meet your goals in high-inflation environments.
5. Liquidity Risk
Like stocks, bonds are issued by companies (or other institutions) and then bought and sold on an open market. And also like stocks, bonds can face liquidity crunches when one side heavily outweighs the other. If you need to raise cash and can’t find a buyer for an illiquid bond, you might be forced to accept less than the prevailing market price to facilitate the transaction.
Bonds are Safer than Stocks, but Not Without Risk
Bonds can help diversify a portfolio, but they can’t completely erase risk from the equation. Bonds are subject to interest rate changes and quickly rising inflation. Bond issuers can become financially fragile during economic downturns or when adverse regulatory changes are passed. At times, you simply may not be able to find a buyer willing to pay par value.
As of 2023, the global bond market is valued at approximately $140.7 trillion, reflecting a 5.9% increase from the previous year. This makes it larger than the global equities by $25.7 trillion. Bonds come with different yields, durations, and creditworthiness, creating a flexible asset class that can fit into the financial plan of most investors.
Always research the bonds you buy like you would a company stock and be sure to consult an investment advisor before making any significant purchases for your portfolio.
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Super Micro Stock Drops Sharply After Earnings on Margin Concerns
Super Micro Computer Inc. (NASDAQ: SMCI) stock is down more than 13% the morning after it delivered its fourth quarter and full-year 2024 earnings report. The curiosity isn’t why the stock is down but why it shot higher in the immediate aftermath of the report.
The headline numbers were below analysts’ expectations. Revenue of $5.31 billion was roughly in line with the $5.32 billion that was forecast. However, earnings per share of $6.25 was down sharply from the $7.63 that analysts were expecting. Furthermore, Super Micro showed another decline in its profit margin, which is spooking investors.
Super Micro: Winning the Race but Not Getting the Prize
Super Micro Computer's revenue has spiked sharply in the last 12 months due to demand for its products in data centers. In the last three quarters, that revenue growth has been matched by strong earnings growth making it not only one of the best artificial intelligence stocks, but one of the best technology stocks to own.
However, even during those quarters, there were concerns that the company was winning a race to the bottom. That is the company’s servers are a notoriously low-margin business. The concern is that it will be difficult for the company to grow revenue at the rate needed to increase earnings at a rate that would support the company’s stock price.
If you were concerned that SMCI stock was priced for perfection, these results are giving you a reason to sell.
Super Micro's Higher Guidance Suggests That Context Matters
Management was quick to point out that there were some mitigating factors to its declining margins. This included selling servers to hyperscale customers who have the power to command higher discounts. Plus, they had some outsized costs due to supply chain disruptions specific to its new Direct Liquid Cooling system.
And based on the company’s forward guidance, it doesn’t believe those problems will be long-term concerns. The company is guiding for revenue between $26 billion and $30 billion in FY2025. The high end of that range is double the revenue the company generated in all of 2024.
In terms of earnings, Super Micro didn’t offer full-year guidance but raised its guidance for the first quarter to a range between $6.69 to $8.27. At the low end, that would be 7% higher than the current quarter and 143% year-over-year.
Super Micro Is Splitting Its Stock
If you didn’t have enough to consider regarding SMCI stock, the company gave investors one more thing to consider. In late September, Super Micro will complete a 10-for-1 stock split. This was the key reason the stock shot up about 10% in after-hours trading.
That means that once the split is completed, current shareholders will receive nine additional shares of SMCI stock for every share they own. However, as investors know, the split doesn’t change the company’s stock's fundamental value.
So why split? In the case of Super Micro it may just be a case of managing its current growth. Revenue and earnings have shot higher on increased demand in the last two years. And consider that just five years ago, SMCI stock was trading for under $20 per share. This split will make the stock more accessible for investors who would prefer to buy full shares.
Is SMCI Stock a Buy Before the Split?
Every investor has to answer that question for themself. However, it’s worth noting that the sell-off in SMCI stock has pushed it near oversold territory. And considering the stock has been trading in a fairly defined range since April, there could be a bounce before the stock split closes.
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Lyft's First-Ever Profit, but the Outlook Is a Speed Bump
Lyft (NASDAQ: LYFT) released its second quarter 2024 earnings report, revealing a remarkable milestone. Lyft’s financial release shows that the company achieved GAAP profitability for the first time in the company's history. However, this triumph was met with a wave of investor caution as Lyft simultaneously issued a less-than-optimistic outlook for the coming quarters, sparking a decline in Lyft’s stock price.
Lyft's Robust Quarter Fuels Optimism
Lyft's earnings report for the second quarter provides an image of robust financial health, with significant year-over-year growth across key metrics. The company reported a total revenue of $1.436 billion, a substantial surge of 41% compared to the $1.021 billion generated in the same period last year. This impressive revenue growth was fueled by a 17% year-over-year increase in gross bookings, reaching $4.02 billion. While falling slightly short of Lyft’s analyst community projections of $4.07 billion, this figure still signifies a healthy demand for Lyft's services. Most importantly, Lyft recorded a net income of $5 million, starkly contrasting the net loss of $114.3 million reported in Q2 2023. This achievement marks Lyft's first-ever GAAP profit, a significant milestone signifying the company's transition towards sustainable profitability.
Several factors contributed to Lyft's impressive financial turnaround. Increased ridership played a crucial role, as did operational improvements likely driven by cost-cutting measures implemented earlier in the year. Furthermore, Lyft achieved a positive free cash flow of $256.4 million, a substantial improvement from the negative free cash flow of $112.2 million reported a year earlier. This positive cash flow generation gives Lyft greater financial flexibility to invest in growth initiatives, manage debt, and potentially reward investors in the future.
Lyft's Operational Strength and Driver Engagement
Lyft's financial performance in Q2 was mirrored by positive operational trends, indicating a healthy and growing user base. Active riders, a crucial metric measuring user engagement, rose by an impressive 10% year-over-year, reaching 23.7 million. Similarly, the total number of rides completed on the platform, including rideshares, bikes, and scooters, reached a new company record, surging by 15% to reach 205 million. This growth in both Active Riders and Rides signifies a growing preference for Lyft's services, likely driven by increased brand recognition, convenient app experience, and a potentially expanding service area.
Lyft's success hinges on attracting riders and maintaining a satisfied driver network. The company's efforts to attract and retain drivers through various incentives and programs appear to be paying off, as evidenced by the record-high driver hours recorded in Q2. This positive trend in driver engagement is crucial for Lyft to meet the increasing demand for rides and maintain its competitive edge against rivals like Uber (NYSE: UBER).
Lyft's Conservative FY24 Projections Signal Caution
While Lyft's Q2 performance exceeded expectations, the company's guidance for the upcoming quarter and the remainder of the fiscal year injected a dose of caution into investor sentiment. For Q3 2024, Lyft projected gross bookings to fall within a range of $4 billion to $4.1 billion, falling short of analyst estimates of $4.15 billion. The company also guided for adjusted EBITDA between $90 million and $95 million, significantly lower than the anticipated $103 million. This conservative guidance, coupled with the projected decline in adjusted EBITDA margin to 2.3% from the current 2.6%, suggests potential headwinds for Lyft in the near future.
Lyft's FY24 projections echo a similar cautious sentiment. While the company anticipates rides growth in the mid-teens and gross bookings growth slightly outpacing rides, the projected adjusted EBITDA margin of about 2.1% for FY24, though improved from the 1.6% reported in 2023, still falls short of current levels. These projections point towards a more challenging operating environment for Lyft, possibly due to increased competition within the ride-sharing market, rising operating costs linked to inflation, and the need for continued investment in technology and driver incentives.
A Bumpy Ride for Lyft Stock
Following the release of its Q2 earnings report, Lyft's stock declined, tumbling approximately 15% in pre-market trading. This adverse reaction underscores investor concern about the company's ability to sustain its current growth trajectory and profitability in the face of challenges. In contrast, shares of Uber, Lyft's primary competitor, responded positively to its recent earnings report, highlighting the diverging investor sentiment towards the two ride-sharing giants.
Recent analyst ratings and price targets for Lyft are mixed, reflecting the uncertainty surrounding the company's future performance. While some analysts remain optimistic, issuing Buy ratings and price targets exceeding current levels, others have adopted a more cautious stance, issuing Hold ratings and expressing concerns about potential headwinds. However, combined, there is still a consensus of “Hold” with an average target price of $18.04, which provides a significant upside of almost 100% for investors willing to take the risk.
Lyft's Journey Ahead
Lyft's Q2 2024 earnings report presents a complex scenario for investors. It showcases the company's impressive GAAP profitability achievement while raising concerns about its ability to sustain this momentum in a dynamic and increasingly competitive ride-sharing market. Moving forward, Lyft's success will depend on its ability to navigate several key challenges.
Attracting and retaining riders and drivers will remain paramount, requiring ongoing investment in innovative features, competitive pricing, and driver-friendly policies. Additionally, effectively managing costs while investing in growth initiatives will be crucial to maintaining profitability. As Lyft steers its course through these challenges, investors will be closely watching to see if the company can maintain its upward trajectory and solidify its position as a leader in the evolving ride-sharing industry.
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